An extremist, not a fanatic

February 28, 2012

Incentives doublethink

The government’s “work experience” programme highlights a widespread doublethink about the role of incentives.

On the one hand, participants in the scheme are threatened with a loss of benefits if they leave after more than a week - presumably to incentivize them to stay on it.

On the other hand, though, the government seems unaware of a perverse incentive in the scheme - that firms have little incentive to hire permanent staff if they know they there’s a supply of almost free labour. Iain Duncan Smith says that “of around 1,400 individuals who have taken part in the Work Experience placement at Tesco, more than 300 have been taken on in permanent roles” without telling us how many people Tesco would have employed without the scheme,

What’s going on here is a common theme. Whilst plenty of attention is paid to the incentives that the unemployed need to find work - as if poverty and unhappiness were not incentive enough - the incentives that companies and the rich face don’t get such scrutiny.

And yet their incentives should come under attention, because there’s a decent body of evidence now to suggest that making the rich richer might not work. High pay and bonuses are not just about greed and unfairness, but might also be inefficient. For example:

- Financial incentives can crowd out other, better, forms of motivation such as social norms or professional pride.

- The Yerkes-Dodson law predicts that high stakes can lead to worse performance - a prediction corroborated by experiments.

Despite all this evidence, the dominant view amongst the managerialist class seems to still be that bosses need high pay to incentivize them. And this claim does not get the scrutiny it should.

In this sense talk of incentives is highly ideological. The managerialist class decides what’s efficient. And what’s efficient is whatever is in its own interest, regardless of what the science says. As George Carlin said:

Conservatives say if you don't give the rich more money, they will lose their incentive to invest. As for the poor, they tell us they've lost all incentive because we've given them too much money.

Comments

"Fines can do better at elicting performance than bonuses."

Though this might not be true if they are small fines. What about the famous Israeli day care centre example?

There's an argument that small fines can lead people to view a decision they once saw as an 'ethical' one (like picking your kid up from nursery on time) as a market transaction where the cost of the fine is worth paying.

Another hypothesis I've heard is that the high pay of bosses isn't to incentivize them at all, but to incentivise their staff. As in, encouraging the staff to work hard in the hope that their efforts will be recognised and they will be promoted to their bosses level.

is there a difference between needing high pay to `incentivize' somebody, and needing to pay a high wage to secure somebody's services?

what I mean is, suppose the level of pay has no impact upon effort, so that anybody who has a job exerts the same effort. In this world, some people may still get paid more than others, because of supply and demand, without there being any behavioural response to pay. I suppose all this tells us is that high pay isn't necessarily about behavioural incentives. And I also suppose if you start from having a high level of pay already, then any performance-contingent payments need to be similarly large if they are to make much of difference to you.

n.b. the above thoughts do not mean I think "performance pay" for high paid execs, is a good idea and come to think of it, nor does it mean I think supply and demand explains high exec pay either. My preferred model for thinking about top execs is as Dukes and Earls, sat on top, extracting rents from below.

"is there a difference between needing high pay to `incentivize' somebody, and needing to pay a high wage to secure somebody's services?"

I think yes, but the two are conflated all the time by different parties for different reasons.

I suspect PLCs think (right or wrong) you just need to pay a load of money to get the talent in the room. But they know that at least some shareholders won't tolerate such a simple message so they create large 'performance-related' packages that enable them to still pay a lot to the talent whilst genuflecting to 'alignment of interests'.

On the other hand I think too many shareholders (or at least the people at asset managers who do the voting) think high pay incentivises and thus they need carefully designed bonus & share schemes to make sure directors do the right things. Then they are shocked when, years later, overall rewards are much higher than they were.

Re the Work Experience scheme, Chris says “government seems unaware . . . . that firms have little incentive to hire permanent staff if they know they there’s a supply of almost free labour.”

That surely begs the most crucial question surrounding this scheme or any employment subsidy, namely do subsidised employees displace regular employees or, in contrast, are the subsidised employees net additions to the workforce. The vast majority of economists are aware that all employment subsidies involve a bit of displacement. So while there may be individual politicians unaware of this problem, “government” in a broader sense of the word is well aware of the problem.

"without telling us how many people Tesco would have employed without the scheme"

FFS, this is beyond naive. Yeah, he also didn't say what the impact of a positive supply shock (ability to hire workers at lower unit labour costs) would be: an increase in PROSPERITY from firms being able to produce more output for lower marginal costs.

'Yeah, he also didn't say what the impact of a positive supply shock (ability to hire workers at lower unit labour costs) would be: an increase in PROSPERITY from firms being able to produce more output for lower marginal costs.'

Oh ho ho ho, very witty, yes. If we mandated a pay cut of 75% for all workers, this would vastly increase prosperity!

I am afraid that you forget that a fundamental strand of Tory thinking is that the working class (or is chavs/scoungers their current terminology) are a fundamentally different species from themselves. Orwell pointed this out in the Road to Wigan Pier and the fashion has come back into vogue. While I may be something of a master of disgusing my dumb insolence I can still spot that look of silent contempt on the face of Cameron, Osborne and many of their ilk.

The ideal primary teaching resource should contain a variety of useful features. High quality teaching resources can be the difference between a constructive, attentive and content classroom and an unproductive and idle one.

The state/EU could pay people not to do paid work, either to retire early or to work fewer hours, so that more people can get paid work - sharing out the employment opportunities as the phrase goes. After all, landowners in the country are paid not to grow things, not to destroy hedgerows and to leave woodland alone. Right now, it's carrots for the rich and sticks for the poor.